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Legg Mason, Inc. (NYSE:LM)

F2Q08 Earnings Call

October 24, 2007 8:30 am ET

Executives

Tim Munoz – SVP, Head of Corporate Marketing andCommunications

Chip Mason – Chairman, CEO

Barry Bilson - SVP of Finance

Analysts

Tom Gallagher - Credit Suisse

William Katz -Buckingham Research

Robert Lee - KBW

Cynthia Mayer -Merrill Lynch

Prashant Bhatia – Citigroup

Michael Hecht - Bancof AmericaSecurities

Douglas Sipkin -Wachovia

Operator

Welcome to the Legg Mason quarterly conference call. (OperatorInstructions) I would now like to introduce your host for today's presentation,Mr. Tim Munoz. Mr. Munoz, you may begin, sir.

Tim Munoz

Thank you and good morning. On behalf of Legg Mason I wouldlike to welcome you all to our conference call to discuss operating results forthe fiscal 2008 second quarter ended September 30, 2007.

This presentation may contain forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995.These forward-looking statements are not statements of facts or guarantees offuture performance and are subject to risks, uncertainties and other factors thatmay cause actual results to differ materially from those discussed in thestatements.

For a discussion of these risks and uncertainties, pleasesee “Risk Factors and Management’s Discussionand Analysis of Financial Condition and Results of Operations” in thecompany's annual report on Form 10-K for the fiscal year ended March 31, 2007;and also, “Management’s Discussion and Analysisof Financial Conditions and Results of Operations” in the company'squarterly reports on Form 10-Q.

This morning's call will include remarks from the followingspeakers: Legg Mason’s Chairman and CEO, Mr. Raymond A. “Chip” Mason; Mr. BarryBilson, SVP of Finance, who will discuss Legg Mason's financial results.

In addition, following a review of the company's quarter, wewill then open the call to a Q&A session.

Now I would like to turn the call over to Mr. Chip Mason.

Chip Mason

Good morning, everybody. Excusing the gain that we made inDecember of '05, this was the second-best quarter we've ever had. We have had disappointing,continued equity outflows, which you and we are both very aware of and we arespending a lot of time on. You should not be surprised with the continuedperformance issues. Obviously, most of these are visible to you in dailynumbers.

However, we remain confident in our managers. We believethat our business model is as good as you can get and we believe that we havesome of the finest managers in the country, and in some instances, in theworld. Managers do have good and bad periods.

The markets for the quarter in general, as you know, wereshaky. The global credit issues were large and constant. The Fed cut thediscount rate and the Fed funds rate and they have projected -- or it appearsto be -- that there will be more to come. The spreads have tightened in mostsectors. An example would be a three-year home equity. The current spreads are100; the ten-year average is 30, and that would be down from a high of 150 in August. So obviously, theycontinue to be well above historic averages, although better and improving.

The ABCP (asset-backed commercial paper) market hasimproved. It seems to improve a little bit every day. The volatility in theequity markets remains. The DOW has fluctuated plus or minus 1% for 23 out ofthe 63 days in the quarter; somewhat of a roller coaster. The DOW started thequarter at 13,500 and then went down to 12,900 mid-August and then closed the endof September at 13,900. So therefore, the indices closed at near record levels.Major financial firms mark-to-market hundreds of billions in securities and wesaw $90 per barrel for oil. A lot of this no one would have predicted as littleas six months ago.

Our net income for the quarter was $177.5 million. As Iindicated -- well as you know -- last quarter not including the gain was ourbest quarter ever; this quarter being our second-best quarter than ever is off7% in net income from the prior quarter but up 24% from a year ago. On adiluted EPS, we are also off 7% from last quarter at $1.23, but up 23% fromlast year.

Our cash earnings per share, which I keep hoping will youlisten to, is an important financial metric, in our opinion, to considerparticularly in our case when it is 30% higher than our GAAP earnings per share.We have considerable intangible write offs for book and tax and it gives you a clearerpicture what our cash generation actually is.

We have continuing operating cash earnings per share of$1.60. Last quarter was a record. We were off 3% from last quarter, but up 20%from a year ago in those cash earnings per share. In actual cash earnings, wehad $231.8 million, also off 3% from our record last quarter, but up 21% fromthe prior year.

Our assets under management went over $1 trillion, which inand of itself is quite a benchmark. We may not have gotten there -- in commonday vernacular – pretty, and maybe not the way you would have liked for us torobustly have gone through it, but we did go over $1 trillion; certainly amonumental task from our standpoint and one of which we are very proud.

We increased in the quarter $19.2 billion, up 2% from lastquarter which was $992.4 billion. $18.9 billion came from market appreciationand $300 million from close. We had solid flows for our long-term fixed incomeassets, up about $11 billion. Our liquidity flows were basically flat, maybeoff a billion. Our equity flows were off $9.6 billion, which is the number thatyou all tend to focus on.

I have to say, involved in that you should not really lookat that $9.6 billion as hopefully a real number because we had the loss of a529 plan which had been announced and that we were well aware of, for politicaland other reasons. Then we had a realignment of a major fund that was basicallygoing to a much broader platform and we had a lot of those assets and thereforewhen they went to an open platform, we lost $2 billion in equity and $1 billionin debt coming off of that platform. So the number, which still is large, wouldhave been more like $6.6 billion if that had not taken place. But still large,still concerning. The lack of equity flows to some managers continues to be anarea obviously of our focus.

There are some signs of improvement and the market’sincreased bias to growth should help us, because as you know, we now have a lotof growth-oriented managers. One of the things that we mentioned that I'll justreiterate for a minute, we do track this, we do look at it pretty hard, but thepercent of our assets in our mutual funds that are beating the averages has nowmoved from 39% in June of '06 which is when we completed the realignment of themutual funds, it has moved from 39% to 55% today. We think that's an importantmetric. We are not beating the band on it because we need more time to beconvinced that this trend is now truly moving in the right way. But we arecertainly encouraged by such numbers.

There were periods when we led all these categories and wewere originally going to talk about this, but we went back and looked at the atten-year numbers and the ten-year numbers we were at 89%, which tells you howstrong we have been for quite sometime in beating the average. Western had beat100% of them, Legg Mason funds had beat 94% and Citi, now the Legg Mason PartnerFunds, had beaten 86%. We love the return to the glory days.

Even our five-year numbers remain strong, even with theseearlier numbers and they were in the 76% range. So we are hopeful, but it's tooshort a time to be convinced that this is doing what we are trying to do.

We do believe performance is the key to our generatingflows. I can't speed that process on. You can beat on me all you want; I don't run the money. I'm very hopeful thatthis is a good sign. We do not interfere with the investment process. We feelthat you if have good managers, you are going to let them run the money and theymake the changes as they see fit.

As an example of that, Capital Management made a decision,came out in August and announced a shift to mega caps which will tone downtheir risk volatility. There are several products and managers that continue toperform well and all had strong performance and flows. They continue to buildtheir U.S.institutional separate account business with a new, substantial mandate.

Noteworthy in the equity mutual funds, Legg Mason Partners CapitalIncome Fund with about $3.5 billion in assets has been moved to four star. It'sin the 9 percentile over the 12 percentile for three years and the first percentilefor five years. We believe this is an example of a success story ofreorganization.

The Legg Mason Growth Trust, which is $1.3 billion, a four-starfund run by Robert Hagstrom, who was put up for one of those, supposedly to beconsidered for Manager of the Year. It is in the second percentile for oneyear, the 31st percentile for three years and the first percentileranking for five and ten years. Both the prior fund, Legg Mason Partners, whichis a Gendelman Fund and the Hagstrom fund are examples, we hope, of things tocome.

Fixed income had a difficult quarter but rebounded well.Western Core and Core Plus Institutional Funds, weak returns most of thequarter. They were ranked in the bottom deciles for July. They rebounded nicelyin September and were running in the top centile for the month of September.Legg Mason Partners Managed Muni Funds, $3.1 billion, our larger muni fund managed by Joe Deane andDavid Fare, versus a Lipper category, were in the second percentile for oneyear, fifth percentile for three years and 19th percentile for five years.

In the UK,long-term fixed income has now shown marked improvement over the past quarters.

International, the appetite for investments internationallyremains high. However, non-U.S. investors sold a record amount of U.S.assets during the month of August. Our assets under management clients domiciledoutside of the U.S.continued to grow and be a focus.

Other news that I will comment on; the board, as you know,had authorized up to 5 million shares in the July board meeting could berepurchased over a period of time. In the quarter we repurchased 1.1 millionshares. Our goal remains to create shareholder value and additionally to continueto service our debt at $50 million per quarter. First priority for cash remainsprobably in the international equity area as we've indicated before.

Just to mention the CEO search, a four-person committee ofthe board has been established for probably some four or five months now. Theyare actively engaged. They are utilizing the assistance of an executive searchfirm. At this point, there has been no deadline announced, but they are moving.

In closing, we focused on growing the business and we havein the distribution side, which is important to us in an area that we've spenta lot of effort in the last six to nine months. We have established some newand exciting relationships with distributors, new product development to meetthe changing needs of investors. For example, the aging population and thefirst baby boomers to get Social Security benefits.

We are confident that certain of our equity managers will returnto their longstanding level of strong performance, and that would benefit ourbottom line substantially. We are certain that we have the strategy and toolsto be and remain a premier global asset manager.

Barry, I will turn it over to you.

Barry Bilson

Thanks, Chip. Folks, I'm going to move fairly briskly inlight of the fact that I believe when you look at the quarter there are veryfew things in here that are going to distract or confuse.

Just to eliminate a question, just to clarify one point, inthe release there is the reference that this 529 plan loss in the retirementplan restructuring cost us about $2 billion in equity AUM. The total loss fromthose two events was about $3 billion. The difference between the $2 billion andthe $3 billion of $1 billion actually was in the fixed income space which wouldbe in both the long-term fixed income bucket as well as the managed accountarea.

Going to the numbers, again, I don't think there are manythings that are going to confuse or surprise. In many respects, this quarter isvery similar to last quarter. If you reflect back to my comment last quarterwas last quarter was “about as normal a quarter as you would see, without a lotof distraction or noise.”

The realization rate on the average AUM is identicalsequentially at about 38 spot mined basis points on an annualized basis versus 38.2for this quarter of last year.

The net distribution expense; again, the encouragement isthe best correlation you have to drive off there is to look at the distributionexpense versus the sum of the funds advisory fee revenue, plus the distributionand service fee revenue. Again, we've been through this random discussion a tonof times. But there are pieces obviously in the fee side that is the paymentstream for the expense.

If you look at that, again, sequentially it's virtuallyidentical plus or minus a couple of decimal places, 41.8% versus 42.3%. Again,that should not surprise. Dealing with just a couple of items that I think youare going to be looking for some clarity on, in the revenue stream actually performancefees are down substantially on a sequential basis, basically identical to lastyear. You'll recall that last quarter there was reference to an annual fee thatwas in that line. Obviously we hope to have it again, but we'll have to waituntil the June quarter of next year. That was like $6 million or $7 million.

There are eight subsidiaries that have products with somelevel of performance fee. Virtually all were lower this quarter than last. Butlast quarter was the strongest performance fee quarter we've had probably sincethe deals closed, with the exception of the December '06 quarter, which againis historically and to be anticipated going to be a quarter with a probablespike, really related to Permal where there are a number of products that hadannual calendar year measurement periods, so we will report all income for thefull calendar year in that December quarter.

Just to save you from going back to your notes, last yearthat number was about $23 million of calendar year measurement period Permalperformance fees. This year we are optimistic, but obviously there is somequarter left to go that that number would certainly be somewhere in thatneighborhood or better for the ’07 calendar year.

It'stough to pay a norm for this thing, but if you insist on trying to dosomething, tweak it depending on what the market environments are. But if youare dealing with a $35 million level, plus or minus $5 million, that's about as“normal” a benchmark as you can have.

It is very unlikely you are going to see this thing ever endup tripling up, quadrupling up; it's not the metric that we are dealing withbut the products that we have performance fees driving off of. You are notlooking at the 20% of performance gain as a starting point in what we aredealing with. So it does have some volatility and variability but not to atremendous magnitude.

Enough on that one. The other operating revenue lastquarter, you may recall was a little bit higher with some extra commissions andaccount fees, the indication at that point was $4 million to $5 million isabout a normalized level. That's where we are sitting for the quarter.

Comp and the benefits relative to net revenue, basicallyidentical across the board, about 50%; 50.5% this quarter, 50.4% last quarter,50.0% the year before, which again, is the concept of the model to try andmaintain margins regardless of what has happened with the revenue.

The non-comp, non-distribution expenses sustained quitewell, actually backed off about $2.5 million sequentially at $142.6 million. Again,certainly an indication that we are over a lot of the transition hump. There wasobviously some discretionary spend, marketing/advertising that eased some thisquarter but you should not be anticipating a dramatic escalation in thoseexpenses absent something new that we would probably try and indicate to you.

What else do I need to point out? The tax rate is identicalsequentially. The other thing I'm sure will be a follow on, so let me addressit now. Two things: on the cash EPS, you will notice that sequentially there wasa meaningful jump in the add-back on the intangible-related taxes. That'sreally a cyclical situation with some imputed interest on an escrow on one ofthe earn outs. It should back off about $7 million next quarter, which wouldtrim about $0.04 per share on the cash earnings per share. You may see it againthis cycle next year. I know that's going to stand out a little bit to you.

The other thing we anticipate a question on is the dilutedshares outstanding with the stock repurchase. I reinforced that we had ameaningful stock repurchase this quarter of 1.1 million shares. That had amarked bias later in the quarter. The impact in this quarter, 300,000 to 340,000 shares, so you'll have an additional650,000 to 660,000 of impact into that diluted shares outstanding count nextquarter.

I know that was quick and I'd be happy to answer anyspecific questions you may have. The other thing I should touch is thenon-operating revenue. Again, last quarter really was the anomaly. It's down$6.5 million sequentially. You recall there was about a $3.5 million gain onthe disposition of a joint venture and obviously there is a lesser amount ofmark-to-market on some investments, predominantly the funding mechanism on someof the deferred compensation plans.

I know that was brisk, but I'm not going to belabor thingsthat I think are probably in line with your view and expectations.

With that in mind why don't I ask Howard to open it up forquestions?

Question-and-AnswerSession

Operator

Your first question comes from Tom Gallagher - CreditSuisse.

Tom Gallagher - Credit Suisse

The first question I have is a follow up on the fixed incomeside. Can you talk a little bit about what's going on there? Chip, I know you talked about there was somedeterioration in performance for a couple months, but you've come back. Thelong-term numbers are still real good.

Can you talk about the visibility or the expectations there?And maybe give a little perspective on how you think clients are looking at thecurrent market? I say that meaning myexpectation would be you wouldn't necessarily see any kind of meaningful pickup in redemptions based on a few months of under performance, but I'm a little surprised that the net flows wereso strong in that area, just because of the recent performance issues. Can yougive a little color on that? Thanks.

Chip Mason

I'll do the best Ican. First of all, in 2002 we had a hiccup in the summer that was different ineffect that it wasn't nearly as publicized and widespread as this market hasbeen, but it certainly was a pretty severe setback. As you probably know, andmany people do know, that Western tends to be much more on the credit side thanother managers. That's really why most periods they've outperformed everybody-- not all, but most. It is because they tend to be a little farther out on thecredit scale than others are and therefore, anytime you have a dramatic orrapid change in credit markets they tend to get hit by it.

I think their clients are well aware of that and I thinktheir clients, at least on the institutional side, more or less expect that in effectthat Western has always been the one that has sort of been heavier in corporateand been out there on the credit side.

The reason I cited 2002 was they were just getting killedthat summer and obviously what happened is the spreads widened, they weresuffering and feeling the pain, obviously as were their clients. By the end ofDecember they had recaptured it all and if I remember correctly, came out withthe best numbers for the year, which I don't anticipate happening quite thatrapidly this time.

But, when markets tend to turn and then turn back andspreads pull in, which is the biggest issue here, they tend to get hit thehardest going in and then come back the fastest as spreads continue to pullback to more norm; whatever norm is in somebody's mind. So

I mean, they are still winning mandates obviously in thelong-term business, which has always been there, where they are best known. Thathasn't seemed to have slowed down. The differential is small, if any. Butobviously, these kinds of markets affect you and affect your thinking and weare hopeful that we will have another rebound that puts us back the way it wasin 2002, meaning as fast as it did.

I hope that answers it.

Tom Gallagher - Credit Suisse

It does. So bottom line is despite the fact that the longcredit trade hasn't worked out in the short term, you still think most of theirclients, the credit story is still resonating with most of their clients on thesales side. Is that fair to say?

Chip Mason

From everything wecan tell that is true, Western has done their usual good job of getting infront of their clients, reminding them how they run money and what they'vedone, wishing obviously that they had seen it coming or didn't have the bump.But it is part of what they do and their long-term record obviously is stillsensational; their short term record is not as sensational.

Having that to be the case it appears that all of their long-termportfolios remain intact. Actually, one of the areas that has been a concernwith us is we always had very good European numbers and the last 18 months totwo years those numbers have gotten weaker which had not been our priorexperience. That's a big market, because that is probably close to $100billion, if not $100 billion out of London.Those numbers have turned back up. That probably is something that will help usmore than we realized, because our concerns were that it had gone too long andthat appears to be better.

Barry Bilson

Just for a point of reference, Tom, this is probably thethird or fourth time over the past 20 years that there has been this kind of dynamicthat has hit Western relative to their approach and their bench strength. Inthose prior occasions, they remained positive in flow in each and everyoccasion.

Tom Gallagher - Credit Suisse

That's helpful. Just one follow up, can you comment on thechange in the distribution relationship with Citi? I realize that doespotentially open up new distribution outlets for you, but can you also talkabout the potential downside risk of what might happen to retention and salesthrough the Citi distribution?

Chip Mason

You're talking about the agreement with the Value Trust, I'massuming that's what you mean?

Tom Gallagher - Credit Suisse

Yes, it is.

Chip Mason

I think that Smith Barney would view this as, they were veryanxious to make sure they had some form of an exclusive arrangement with the ValueTrust. they got that. The parameters of that were widened dramatically whichdoes give us a broader ability to distribute the product on a much wider base. Sofrom the standpoint of Bill and his team, that was an important thing. My guess is either both parties thought theywon or both parties thought they lost. But they came out with something thatthey were relatively happy with on both sides.

The retention issue is a Smith Barney issue, not ours. I'm going down the path I think you're askingme as a question. The retention issues only -- probably as far as the agreementis concerned -- the former Legg Mason brokers that own a lot of the Legg Mason Fund,I think Smith Barney viewed this as an important retention vehicle to keep themwith Smith Barney. Not that I think they are going to leave, but I think theyviewed it that way. They have had some retention issues over the past couple ofyears and so they, Smith Barney, are more sensitive to that subject thanprobably others. But I don't think this is really a big factor in that issue.

It does open up new areas for us to sell the funds, though.

Operator

Your next question comes from William Katz - BuckinghamResearch.

William Katz - Buckingham Research

Good morning, everybody. You guys are going very quick and Ijoined a little late and I apologize for that. A clarifying question for you; canyou just review if you gave any comments on why the distribution margincompressed sequentially?

Barry, I wasn'tfollowing your guidance on performance fees. Was the $35 million plus or minus $5million inclusive or exclusive of the annual reset at Permal?

Barry Bilson

Let me do the easy one first, Bill and please try and joinus on time in the future. The guidance on the $35 million is a “normal”quarter. The $ 23 million of last year, again, we would hope a meaningfulnumber that would occur this year would be on top of that. So that would be thebase of the annual drop on top of that from a standpoint of your benchmark.

Relative to the distribution Bill, if you want to go throughit in detail we can do it offline. I know what metric you are looking at, youare looking at the net distribution spread at about an 81% negative thisquarter versus 75% last quarter. Again, the relationship of that distributionexpense is not exclusively to the distribution and service fee revenue. Youhave to look at the fund revenue as well. A prime example is Permal whocertainly grew in the quarter, average assets were meaningfully higher where theyhave no distribution fee revenue. It is a portion of their all-in managementfee that is disbursed.

If you utilize the metric that I think will work best foryou, i.e. relating the distribution expense to the sum of advisory fee revenueon funds plus the distribution of service fee revenue, you are going to findthat basically was identical sequentially, 41 spot, eight this quarter, 42.3last quarter. So if you use about a 42 level it may creep up or down over timebut it's not going to be moving multiple percentage points.

William Katz - Buckingham Research

Thanks, that isperfect, thank you. I am sorry for being tardy. Chip, I was curious as I lookat the liquidity business, that was most surprising relative to my expectationand given what we have seen with some of your competitors and even what we sawon the retail fund flow data, can you give us a little background on what'shappening there? Is it a non-U.S. issue? Is it a performance issue? What sortof plans are there to build that business?

Chip Mason

I don't really know. As you know, this is a newer businessto us, not that we haven't been in it a long time but we were a tiny player upuntil the Citi acquisition. So to some extent, I suspect we are still onlearning curves on this. But remember that our key distribution in this, is theCitibank channel. We are not out broadly on a marketing basis in the businessother than through the Citibank channel. That could be a factor.

I don't know if we know the reason. The flows were basicallyflat and others I know have had some very strong flows in here. It could berelated to performance; it could be related to the channel we have versus thechannel others have. It could be related to pricing. I don't know if we knowthat answer. The numbers have remained fairly constant through the year and Ianswered you in probably the only way I can.

William Katz - Buckingham Research

Just curious on the institutional business, it looks like LAMCO actually outperformedpoint to point. Can you step back and talk a little bit about the pipelinetoday versus maybe last quarter or a year ago and were you seeing any kind ofplus or minuses as you look forward?

Chip Mason

I don't know if I cananswer that because I don't have last year's numbers here. I can tell you that our one mandate -- that hasbeen funded is strong; probably at least as good as last quarter. A year go,unfortunately, Bill -- Barry can get it for you but I don't really know whatthey were a year ago.

I would say in that area we probably aren't seeing much, ifany, change from what I can tell. If that is different we can certainly findout. I think that mandates have remainedstrong and that long-term bond business, which has always been the sweet spotof Western in that core area, appears to be more or less as usual.

Barry Bilson

Bill, just so my legal folks don't get irritated, if I giveyou something, I will give it to everybody. The current pipeline is strong,maybe not at an all-time high but certainly well above the average relative tolast year; probably a little bit lighter. You may recall that the December '06quarter was an exceptionally strong quarter, I think it was almost $12 billionof inflow, not wholesale different, but probably not quite as high as a yearago.

Operator

Your next question comes from Robert Lee - KBW.

Robert Lee - KBW

My first question is related to the flows and to the business of Smith Barney and Citi. Isit possible to get any kind of better color on where you are seeing the realoutflows there? Is it in the rack product? Is it in the fund products? It wouldbe particularly helpful maybe to get a sense of even the products that areperforming well? Are you seeing outflows in those from Smith Barney just asthey migrate to other products and deemphasize the Legg Mason Partners productsbecause they have so much of it?

Chip Mason

Well, that is the key right there. The outflows, I'd like tosay to you that we believe we've troughed on the mutual funds side, and I thinkwe do believe that; but the truth is, we don't know. We'll see, but the numbersdo appear on the mutual funds side to have settled in a pattern that it feats togrow; in fact, it maybe even shrinks a little bit. So we are hopeful that thereis a sign that we are reaching the lowest or lower ends of those flows.

In the separate account area, the SMA, those flows havecontinued and might even be up a little bit, but not appreciably. We don't knowthe length of this. Our view was that we would have them for two years or more.Right now we are probably bleeding in the more as much as anything else,because we are approaching two years.

As I've said before, I think performance is the answer tothis and we have signs of better performance so that would certainly help ifthat kicked in. Most of this, I believe, is the separation of companies. Bythat, I mean this was fundamentally the Smith Barney product. It was part ofthem. It was part of the same entity. Whenever you see this happen and they goto a broader open architecture -- and that's too broad of a way to describethis, but to try and get my point across -- you see a wider outflow on what wasthe product that they had because they are purchasing more of the newerproducts that are coming in. So you are really not getting incoming flows. Whatyou are doing is fighting to just hold on to what you have.

I think that is in fact what's going on here and as the SMAplatforms broaden and they have more and more new people on the platform, theplatform that was Smith Barney’s which is now Clearbridge isn't getting thepreferred flows that they did before. Somewhere, that will go away. I can'ttell you where. We are encouraged because it does not appear, at least on themutual funds side, to be going south any more. It appears to have leveled andmaybe even turned a little better. We'll see. All we can do on this is justkeep you advised.

I do believe and have said all along that the only thingthat will help us is performance. If you went back, because we looked at thisfor all the major brokerage firms, and looked at what their participation waswithin their firm of their own funds versus other funds, what percentage of thetotals they got, they all went through a pretty dramatic reduction from maybethe low to mid 30s down to the high teens. Fortunately or unfortunately -- Ithink unfortunately for us -- during that period where some of the major firmshad their big fall off, Citi held up better than most because their performanceat that time was better than everybody. Iknow when we were doing the study, they had the best numbers, which didsurprise us. I don't mean that in any wrong way. We just didn't realize thattheir numbers had been as strong as they were during that period which in theten-year numbers I gave you, we included Citi in that number and at that point overten years, 86% of their funds out performed and in five years, 76%. So you cansee their numbers really, up until this recent period, had been pretty strong. Theiroutflows really came later and unfortunately we probably got most of thatburden.

Hopefully that answers you because I don't think anybodyreally knows the answer.

Robert Lee - KBW

No, that's helpful. A follow-up question on Permal. If I recall you shouldhave a contingent payment coming up, I guess this quarter. Can you just remindus about the size of that?

Chip Mason

$240 million. It is paid somewhere between November 1 andNovember 30 or something like that. It's very soon, you're right.

Robert Lee - KBW

Part of that you can pay in stock, too, I believe?

Chip Mason

Yes. At the current time we are looking to pay it in cash.We will see.

Robert Lee - KBW

I assume that will increase the intangible amortization aswell as some of the tax benefit?

Chip Mason

No, it won't.

Robert Lee - KBW

No, it won't? I'msorry, could you repeat that?

Barry Bilson

Effectively, Rob, the entirety was booked from an accountingperspective; it is really viewed almost as an installment obligation in the mix.What you see in the financials is reflective of 100%.

Operator

Our next question or comment comes from the line of Ms.Cynthia Mayer - Merrill Lynch.

Cynthia Mayer - Merrill Lynch

Good morning. I am just wondering if you can update us alittle bit on the search for an international equity firm and remind us againof the size you are looking for and anything we should know about the timelineon that?

Also, I am wondering, maybe somebody asked this already but,if you know if Citigroup has sold any of its shares, how many they still have?

Chip Mason

I will take the last one first, because the answer is not tomy knowledge, they own about 6% if I remember.

Barry Bilson

8.5 million shares.

Chip Mason

I don't think they've sold any more shares, but truly Idon't know. They had to get under 10%; supposedly because of banking rules. Tomy knowledge, what they've sold is it. I mean, they haven't sold more. But wehave no reason to track that. It's their call.

I probably have been doing this with the internationalequity firm for four or five years. We have seen three or four firms that wefind extremely interesting over that period; maybe four or five. We have acouple firms that we certainly have interest in now. I have absolutely no ideawhen, if, how and probably even if I did, I couldn't tell you or wouldn't tellyou. I really have nothing else I cansay on that other than our interest remains there.

Cynthia, just to put this in perspective, we areunderweighted, as you are well aware, on the international equity side, whichhas hurt us during the past several years and we are very cognizant of that. Weare going to continue our quest, certainly not on the fixed income side, wedon't have that issue, but on the equity side. It is part of our long-term planto be moving in that direction. Some of our own managers now have gone deeperinto that space. Brandywine as an example has over $10 billion in basicallyinternational equity product and their bond funds which are now $25 billion to$30 billion are virtually all directed in that direction.

We are having more shift even internally, because we arefollowing where the money is and where the interest is.

Operator

Our next question or comment comes from theline of Prashant Bhatia - Citigroup.

Prashant Bhatia –Citigroup

In the release you talked about 7,000 or 8,000 new advisoryrelationships that you've got since the beginning of the year. Can you give usa feel for the flows that you're seeing from those new relationships and maybetalk about the two or three key products that are of interest to those newrelationships?

Chip Mason

I think what we aretalking about there, these are brokers. The way we count this, and we do thison a 12-month cycle, meaning if somebody doesn't put a ticket in for 12 monthsthey go off the list. But every time a broker drops a ticket in a 12-monthcycle that means they have used our product and we record that as a newadvisor. Because typically, if they will put in one ticket you have a very highprobability that will you get more business from them. So most of you will findthat many of these distribution organizations in all of the firms do count newtickets, by new ticket meaning the first time that broker has put in a ticket. Thatis what that's indicating.

Prashant Bhatia –Citigroup

What are those new tickets tending to be for, what type ofproduct?

Chip Mason

I think it's prettymuch across the board. We are trying to see if there is any trending to it, butat least to my knowledge, or at least what the distribution people are tellingme, it is not significant enough in any given area. We did get a fair amount oftickets on the Western funds because they had the numbers and it gave thebroker a second place to be putting money. That was certainly something that wesaw a lot of tickets on. Other than that, I would say there's probably nothingsignificant. Some of the funds that are performing well are beginning to seetickets. But if I told you anything more than that, I probably would bemisleading you because it doesn't mean anything there.

Prashant Bhatia – Citigroup

On the share repurchases, Chip, you said in the past whenyou do a repurchase you really want to move the needle, you don't want to dosmall amounts. Should we take, based on the million shares that you've done,you are just getting started here or how should we interpret that?

Chip Mason

What I said on moving the needle was when we made anacquisition, if we made one, it would have to be big enough. I think we are talkingabout it would probably have to be $1 billion or more just because it wouldn'tmove the needle. I mean, if we did asmaller manager and it was $300 million, it wouldn't move the needle. If we made an acquisition that was probably going tobe $1 billion or $2 billion in costs because if we didn't do it, we wouldn't bemoving the needle. We wouldn't see it in earnings for quite some time, so thatwas the point.

On the shares -- and I made the comment in relationship toshares because I said that if we did an acquisition we probably couldn’t doboth; we couldn’t be buying shares andmake a major acquisition because as the board views this, that would be doubleleverage meaning we would be borrowing on the one side and buying shares.

Our share repurchase program, which the board is nowcomfortable with in a general sense, probably is not going to speed upappreciably. I think the board’s comfort level, as we begin to pay the debtdown that we currently have, will go up. Remember we still have, as wementioned before, a $240 million payment to Permal in November and we have $420million, I think it is, of debt coming due in June. So we have some pretty bigcash payments. Granted, our cash flow is there but you can only stretch it somany ways.

So at the moment, I would say the pattern that we are in, Iwish we were a year from now because our pattern would potentially be a lotdifferent. But until we continue to get things paid down and paid off, I don'thave to deal with you as analysts but I have to deal with the board on theother side. I have one side that feelsas though we are moving too fast and the other side that doesn't feel we aremoving fast enough.

Prashant Bhatia –Citigroup

Just on the European acquisition, you are looking for a CEOat the same time. Is this something that you would wait to at least get a CEO inplace before you went ahead with something like that, or are you comfortablejust doing an acquisition before getting a CEO in place?

Chip Mason

This one has two sides to it. I think that's a very goodfundamental point. Certainly the company you're going to acquire might hesitatebecause they might want to know who the new CEO is going to be. So from thestandpoint of the company to be acquired, that's an issue, because I know anumber of our managers keep telling me, well you could just be here, even ifyou don't have to handle all this stuff on a day-to-day basis, just be here.Who knows if that's going to happen? So that's a normal question coming from apotential acquisition.

The thing I would say to you is, in our history up until wedid Citi, we never did an integration of any consequence. Everything we did wasin the vernacular, a [inaudible] so you didn’t even know it happened. We justowned the company and then they went on and we went on as we were. I do notenvision us doing anything that would cause any internal issues in terms ofhaving to do systems.

I mean, when we did Permal as an example, or Royce orwhatever, they already had all of that, and I would envision this to be thesame. The only issue I think that could come up is I don't think from our sideto wait because I think the board’s view would be that it's probably just aswell as if I handled that. But I could see the other side hesitate.

Operator

Your next question comes from Michael Hecht - Banc ofAmerica Securities.

Michael Hecht - Banc of America Securities

Can I get a little bit more attribution across the equityoutflows you saw? I mean $10 billion less the $2 billion, is it possible to geta better sense of how much was Clearbridge versus Legg Mason Capital Managementversus Private Capital Management and how much may be offset by inflows intoRoyce and Brandywine and Permal? Is it also possible to geta sense of where the assets ended at the quarter at Clearbridge versus LeggMason, some of the trouble areas?

Chip Mason

They are pretty much even. Clearbridge is certainly not thelargest, if that's the base of your question. The issue, it's really those outflowsand we listed them as equity outflows of $2 billion. The whole outflow was $3billion because $1 billion of it, which was in this pension fund -- I guess itwasn't a pension fund -- the company went to an open platform.

I would say they are pretty much even across the board. Itmay be 40/30/30 or 40/32/28 or something like that, but it's not dramaticallydifferent. If you take the outflows leaving the pension fund alone.

What was the rest of your question?

Michael Hecht - Banc of America Securities

I was trying to get a sense as to at the end of the quarter,how much of a change or where the assets ended the quarter across the different fundcomplexes?

Chip Mason

We haven't normally given those out. Clearbridge is down atouch. They are actually, it is an interesting thing. I think Clearbridgeduring this whole cycle obviously the market has responded to them, maybebecause of flows, maybe off 2% in total assets. It really isn't down much atall. Their total assets are within 2% or 3% of where they were a year ago orsix months ago.

The theory that their assets are down a lot is really justinaccurate. That would be maybe a little less true in some of the others. Onthe other hand, we have other managers that are off, but it has been prettyeven. I mean the discussions are always around Clearbridge which is a littleunfair to them, because they are getting more the brunt of this than the factsare.

Michael Hecht - Banc of America Securities

Assets like Legg Mason Capital Management and PrivateCapital Management, are those down a bit quarter over quarter?

Chip Mason

Yes.

Michael Hecht - Banc of America Securities

Flows that you are seeing into Royce and Batterymarch, how havethose held up?

Chip Mason

Generally prettydecent but slow downs in some of them. Certainly if Brandywinecontinues to have relatively strong flows, a lot of it is institutional so itgets much lumpier. Meaning you all, when you're commenting to me very often --I don't mean you specifically but just in general -- the only numbers you canget are these retail fund numbers. Our numbers are very skewed, as you know, byinstitutional because it's the bulk of our assets and those numbers tend tocome in much lumpier because they are based on when the bids go out and itdoesn't happen every day or every week. You may have one week where you took in$6 million; you may go two weeks where you take in $100 million here and $200 millionthere.

In the case of say Brandywine,institutional is extremely important to them and they do come in very lumpy andbig. That would be true of many of our managers that aren't totally into themutual fund business. Royce would be different in the fact that their businessis heavy mutual funds. They are up year over year. They are probably quarterover quarter either flat or down a little bit.

Barry Bilson

Mike, I understandwhat you are trying to get to, but we have never micro-detailed the stuff. The commentthat we made in the midst of it is there is really not an escalation, not torepeat, but obviously we had a couple of situations of magnitude that certainlywere outflows but really one-off.

The other dynamic is it gives some optic here that may makeyou a little uncomfortable, and I think it's part of what you're trying to getto. There is not an escalation of any magnitude in the outflow in the big threeequity managers but there is a bit of easing in the inflow into the small capspace industry-wide and we are participating in that. With the disruption inthe marketplace in the September quarter, there was some easing of the inflowinto the hedge fund and the fund to fund space.

It's still positive, but it was not as strong as a couple ofthe preceding quarters. So when you don't have the benefit as strong and positivenumber on a couple of the managers, it tends to make the total look not assolid.

Michael Hecht - Banc of America Securities

That's helpful. Just one last quick question on the balancesheet. You ended the quarter with $400 million of net cash. How should we thinkabout how much cash you actually have available at the parent or excess that'savailable for repurchasing stock, et cetera?

Barry Bilson

Probably about $500 million but again, remember we have somecontingent payments coming up; we have $240 million right around the quarter.

Michael Hecht - Banc of America Securities

And then whateverdebt you guys talked about that you do each month?

Barry Bilson

Each quarter.

Operator

Your next question comes from Douglas Sipkin - Wachovia.

Douglas Sipkin - Wachovia

Chip and Barry, you guys seemed to indicate that you felt --obviously no one knows for sure -- but that the outflows for equities werestabilizing a little bit. At least initially you have that feel. I'm justwondering in the context of obviously the long-term performance of the Legg fundsis undisputed, but it's been several years now. It feels like we are moving tomore of a three or four-year time period where the performance is not as goodas it is has been historically.

I'm just curious, do you guys feel comfortable that won'thave somewhat of a more longer term impact on people's view towards the products,in light of your comments that you felt like outflows were starting to slow alittle bit?

Chip Mason

Doug first of all, you have to always separate from what ourwishes and hopes are and what the realities are. Sometimes, I constantly givemyself a reality check against my hopes and desires. It's impossible for us toknow this. The signs that we're seeing are encouraging and we don't want topromote it. We don't want to beat the drums because it could go the other wayin the next three months. We did anticipate for a couple of years that becausethe Smith Barney funds were no longer Smith Barney funds -- which would be trueof any situation probably of this nature -- that if you had strong performanceduring this period a lot of these issues wouldn't be around, but if you hadweak performance during the period you would have an issue because theseparation means you have a likelihood to have outflows. This was a purchase.It was a separation.

I was trying to speak to that more than the performanceside. I do think the performance side certainly affects it, but I think thefactual side of the separation is a real factor in this as well.

Douglas Sipkin - Wachovia

I know you mentioned in reference to the Citigroup shares,it's completely their call. Are you guys at least concerned maybe just from thestandpoint of the changing of the distribution relationship that maybe theydon't have as much of a invested interest in you guys doing as well or am Ireading too much into that?

Barry Bilson

You are reading toomuch into it.

Chip Mason

I don't see this asan issue at all. I mean they may sell, they may not sell. I doubt if they dosell. We have institutional holders that are larger than their piece. So it'snot a weighting overhang, but I really don't see them as a seller. I think thattheir feeling was that they should have some long-term interest in us and whatwe do and we certainly work with them in many, many, many ways, not just inthis retail piece that you all see visibly.

I wouldn't be concerned about that; now watch, they willsell it tomorrow. I mean, there is no indication and I do talk to Chuck and Louand others reasonably frequently and I don't think that's an issue.

Barry Bilson

They are a key strategic partner in the distribution for usand it was a very amicable arrangement. They still do have the exclusivity inplace on the primary share plays as the retail share player. They have somebroadening capability outside of that but the relationship is as solid as everand very important to us.

Operator

Ladies and gentlemen, this concludes our Q&A session atthis time. I am going to return the conference back over to the panel.

Chip Mason

I'll just say in closing, because I know that you all have acall coming up that you're interested in getting on -- the analysts, that is -- and one thing I was going to say and Barry didsay it is, really the difference in these earnings is performance fees and Iassume you all could figure that out fairly quickly, were the performance fees whatthey were last quarter, you wouldn’t have had a differential.

I think you can see that by just looking at the numbers. AsI indicated, we are encouraged by the equity performance, but it is really toosoon to be confident. There are better signs things are better on some of theperformance fronts, but time will tell this.

The other thing I wanted to just mention to you -- and Iwill do this from time to time with you is-- go back and take a look if you can atwhat the firm has done over the last four or five years. Very often I don'tthink we get the proper -- but if you look at our net income, five years agofor the first six months it was $119 million then $178 million and then $234 millionand then $300 million then $368 million; that's in successive years. To go from$119 million to $368 million over that four-year period using '03 as abenchmark is no small feat. Earnings from $1.07 to $2.55, we have continuouslymarched along, sometimes not as broad and with as great of an increase as youwant.

I use as a barometer very often what Barry refers to as theevolution of quarters. I've done thischart that some of you have seen where we take every quarter and show what weearn per share per quarter and we do this every year, religiously. If you takethose quarters and just look at it we have, even during this cycle which hasbeen a lot of work and we've absorbed a tremendous amount of cost withoutsaying a whole lot about it, our average quarter in 2003 was $0.45 and in 2004 itwas $0.56 and 2005 was $0.88 and 2006 was $0.96, and 2007 was $1.12. So farthis year it's $1.28. That really is what we are supposed to be doing.

We obviously have had times with some bumps, but we’ve prettymuch continued to move forward and as I said, maybe not as fast, but we giveyou pretty consistent numbers even at times when you don't think we are.

We always thank you for listening and appreciate yourquestions. Hopefully, we will talk to you again in the near future. Thank you.

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